Progress and next steps for China's Belt and Road Initiative

An ambitious blueprint for the region, China has championed its Belt and Road Initiative (BRI) as a vehicle for Chinese-led integration and development. To date, the project has been long on rhetoric and short on implementation, with related economic activity showing little sign of a step change. That will change in the coming years, but The Economist Intelligence Unit still believes that several implementation obstacles mean that the project is likely to fall short of its grand ambitions.

On May 14th–15th, with 29 heads of state in attendance, China convened the inaugural Belt and Road Forum (BRF) for International Co-operation to promote its flagship diplomatic trade initiative. The BRI (previously known as "One Belt, One Road"), a loosely defined framework comprising China and over 60 countries, is composed of an overland "Silk Road Economic Belt" linking China to Europe via Central Asia and the Middle East, alongside a "21st Century Maritime Silk Road" connecting China to Europe via South-east Asia, South Asia and East Africa.

Chinese state media have invoked poetic parallels between the BRI and the ancient Silk Road, when the Ming dynasty was at the centre of world trade and commerce. The Chinese president and chief champion of the project, Xi Jinping, has presented the BRI as an antidote to rising global protectionism, labelling it "the project of the century".

Limited trade impact, deficit risk

Despite high-level Chinese support for the BRI, the economic impact of the project has been muted to date. Since Mr Xi first proposed the BRI in 2013, we discern no dramatic shift in the make-up of China's global trade relations.

In terms of merchandise trade, two-way flows between China and the 65 countries that the Chinese government has identified as belonging to the BRI have remained fairly constant. In 2016 two-way trade reached US$962.6bn, accounting for 25.8% of China's external trade. This number has remained largely stable in the years since 2013, when the BRI was first announced, hovering around 25%. In the first quarter of 2017 this proportion rose to 26.7%.

China's exports to BRI countries have performed better than imports. The BRI countries' share of the value of Chinese exports stood at 27.9% in 2016, compared with 25.8% in 2013. They did not grow strongly over that period—by only 1.8% a year on average in 2014–16—but have held up better than China's exports to other parts of the world. Imports from BRI countries comprised 23% of China's inbound shipments in 2016, a slide from 24.1% in 2013—they declined by an annual average of 7.5% in 2014–16.

The slippage in the proportion of China's imports from BRI countries reflects softer Chinese demand for commodities and lower global prices for such items. Exports from BRI countries, which are mainly developing economies, are dominated by natural resources, but growth in Chinese domestic investment is slowing steadily. Future Chinese demand will be driven more by the needs of households and advanced manufacturing; however, the consumer goods and capital equipment they seek will generally be exported by developed economies not within the BRI.

For Chinese exports, the rising share heading to the BRI region may confirm suspicions that the initiative is designed to help to export China's industrial overcapacity. Rising demand in fast-growing developing economies clearly presents opportunities for Chinese metals, building materials and construction equipment firms, particularly in the light of weaker domestic activity in such sectors. Chinese firms engaged in BRI projects will also lean heavily on local suppliers.

As such, there is a risk that the already-large goods trade surplus China maintains with the BRI region could rise significantly. In 2016 China had an accumulated trade surplus of US$231.8bn with the BRI countries (by comparison, China's surplus with the US ran to US$250.7bn). A failure to lower the surplus could eventually compromise the viability of the BRI, as it will stoke political and economic concerns. China appears sensitive to the issue and has pledged to host an "import trade expo" for BRI countries looking to export to the country in 2018.

Investment has underwhelmed

Promises of Chinese investment may help to offset concerns about the trade deficit. On this front, there has been a more telling step change since the BRI was launched in 2013. China's total overseas direct investment (ODI) in BRI countries accelerated to US$21.4bn in 2015, up strongly from US$13.6bn in 2014 and US$12.6bn in 2013. It is worth nothing that partial data on ODI from 2016 show a 2% decline in non-financial ODI across the BRI.

Nevertheless, there is also less here than there appears on the face of it. Over 60% of Chinese ODI flows to BRI countries in 2013–15 were directed to Association of South-East Asian Nations (ASEAN) countries, with Singapore attracting by far the largest share. That investment is unlikely to be related to the core infrastructure-development purpose of the BRI, and will have more to do with the attractions of the Singaporean business environment.

Moreover, the share of overall Chinese ODI flows heading to the BRI region has actually fallen in recent years. We estimate that these flows amounted to 10.2% of China's total ODI in 2016, compared with 14.7% in 2015 and 11% in 2014. There have been much stronger rises in Chinese investment in developed markets in North America and Europe over the same period, with Chinese firms acquiring brands and technology in a bid to raise their competitiveness and invest in perceived safe assets, notably property.

Caution about investment in the BRI region is understandable. Operating environments in many of the countries are challenging. Chinese banks are already facing a rise in non-performing loans tied to their domestic lending; they may not want to risk a further deterioration in their balance sheets by lending to firms investing in the BRI region. Similar concerns pertain to loans to BRI country governments with high-risk sovereign profiles.

The receptiveness of host countries to Chinese ODI may have also been a factor in constraining investment. China-backed overseas infrastructure projects have proved politically controversial in several countries, especially if they rely largely on Chinese subcontractors and labour. In Kazakhstan, the government was forced to abandon plans in 2016 to allow increased foreign involvement in the agricultural sector following nationalist protests, which appeared to be motivated by fears that the reforms would allow Chinese investors to acquire agricultural land.

Concessional lending has accelerated

In contrast to weak trade and investment figures, there has been a meaningful rise in contracted projects involving Chinese firms in BRI countries. Most of these projects are supported by Chinese concessional loans financed by the Export-Import Bank of China (China EXIM Bank). Such loans offer discounted financing in return for negotiated benefits, such as guarantees on project tenders or importing Chinese labour and capital. Loans may also be granted as part of resource swaps or sovereign guarantees.

Turnover from completed contracted projects signed in 2016 between China and BRI countries grew by 9.7% to US$75.9bn, according to the Chinese Ministry of Commerce. Contracts in BRI countries account for almost 50% of China's total turnover in overseas contracting projects. The pipeline also appears strong: the value of newly signed foreign contracting projects in BRI countries rose by 36%, to US$126bn, in 2016.

Data on contracted projects serve as a proxy for figures on concessional lending, which are sensitive and largely unavailable. Sporadic data from 2014 provided by China EXIM Bank shows outstanding concessional loans standing at Rmb252.2bn (US$41bn). We estimate that these loans expanded at an average rate of 20% a year in 2004–14, despite low rates of repayment. This has increased the level of risk in local investment projects, particularly in countries with poor economic management.

Push coming, but may fall short of grand ambitions

Although the above largely suggests that the BRI has been more rhetoric than action to date, there will clearly be a big push behind the programme in the coming years. Commitments at the BRF made by Mr Xi, where he outlined additional loans and grants of around Rmb540bn for the BRI, suggest that investment will be more forthcoming. In Pakistan alone, Chinese investment of around US$57bn has been promised in the China-Pakistan Economic Corridor.

The BRI region is therefore promised a significant boost in the financing available for infrastructure development in the coming years. We think that these investments will underpin higher trade volumes between China and the region. Besides trade in relation to project work, the establishment of a more integrated infrastructure will help to stimulate crossborder flows by lowering costs and opening up new markets. In turn, stronger trade flows will underpin GDP growth and fiscal revenue creation.

Despite being a promising initiative that we think is set to deliver regional economic benefits, we still believe that the BRI will fall short of its grand—although admittedly vague—aspirations. Issues relating to the trade deficit, credit risk and political tensions will complicate implementation. Ultimately, Mr Xi has pushed through the high-risk strategy because he sees both economic and political dividends for China. However, the perception that the project has a geopolitical dimension may ultimately make other countries hesitant to participate.